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Reforming the UK Corporate Governance Code: proposals for a shorter and sharper Code

Reforming the UK Corporate Governance Code: proposals for a shorter and sharper Code

Reforming the UK Corporate Governance Code: proposals for a shorter and sharper Code

Regional Capabilities:

January 25, 2018

The Financial Reporting Council (FRC) is consulting on proposals for a comprehensive revision of the UK Corporate Governance Code. The changes will affect all companies on the premium segment of the Official List and other companies that voluntarily agree to comply with the Code.

The FRC's overriding objective is to ensure that the Code remains "fit for purpose" and continues to promote improvement in the quality of governance. It is proposing to keep those parts of the current Code that are still relevant and adapt others to reflect the changing economic and social climate to ensure that UK-listed companies achieve the highest standards of governance.

As part of this it is proposing to "shorten and sharpen" the Code. The supporting principles from the current Code have been removed. Some have been incorporated into the new principles or provisions, while others have been moved to the separate "Guidance on Board Effectiveness".

The FRC notes that over time Code compliance has focused on the "comply or explain" aspects of the provisions rather than the application of the principles. The revised Code therefore refocuses on applying the principles as well as the need to comply with the provisions (or explain any failure to comply).

The proposed revised Code incorporates recommendations from the government's 2017 consultation on corporate governance reform, the BEIS Select Committee Inquiry and the FRC's 2016 report on corporate culture and the role of boards. It also takes into account recent reviews on gender and ethnic diversity and input the FRC has received from a broad range of stakeholders.

Proposed key changes

The proposed Code will remove the current relaxations for companies outside the FTSE 350. These currently apply to the provisions on externally facilitated board evaluations, the annual re-election of directors, the proportion of non-executive directors on the board, and audit and remuneration committee composition.

A new provision requires the board to set up a method for gathering the views of the workforce. This would normally be through a director appointed from the workforce, a formal workforce advisory panel or a chosen non-executive director.

A new provision requires for the board to explain in the annual report how it has engaged with the workforce and other stakeholders, and how their interests and the matters set out in section 172 of the Companies Act 2006 influenced the board's decision-making.

A revised provision requires that, when more than 20 per cent of shareholder votes are against a resolution, the company should:

explain, when announcing voting results, what actions it intends to take to consult shareholders so it can understand the reasons behind the result;

publish an update within six months of the vote; and

provide a final summary in the annual report, or in the explanatory notes to resolutions at the next meeting, on what impact the feedback has had on the decisions the board has taken and any actions or resolutions now proposed.

Section 2: Division of responsibilities

A new principle provides that the chair should always show independent and objective judgment. In contrast, the Code currently only requires the chair to be independent on appointment.

A new provision provides that the independent non-executive directors, including the chair, should make up the majority of the board. In contrast, the current requirement is that at least half the board, excluding the chairman, should comprise independent non-executive directors.

The updated provision on director independence states that non-executive directors are not independent for board and committee composition purposes if they do not meet the independence criteria. In contrast, the Code currently only requires the board to take these criteria into account when considering independence.

Section 3: Composition, succession and evaluation

Appointments and successions plans should promote diversity, not only of gender but also of social and ethnic backgrounds.

A new provision expands the scope of the nomination committee's role to ensure that plans are in place for orderly succession to both the board and senior management positions, and to oversee the development of a diverse pipeline for succession. To improve transparency, the annual report should, among other matters, describe the actions of the committee in these areas, and include information about the gender balance of those in the senior management and their direct reports.

Section 4: Audit, risk and internal control

This section substantially reproduces the existing Code.

Section 5: Remuneration

The remuneration committee will have a broader remit. A new provision requires it to oversee remuneration and workforce policies and practices, taking these into account when setting the policy for director remuneration. The annual report should, among other matters, explain the company's approach to investing in, developing and rewarding the workforce, and what engagement with the workforce has taken place to explain how executive remuneration aligns with wider company policy.

There is a new recommended minimum vesting and post-vesting holding period for executive shares awards of five years (currently three) to encourage longer-term outcomes. There is also a new provision that remuneration schemes and policies should give boards discretion to override formulaic outcomes.

Before appointment as chair of the remuneration committee, the appointee should have served on a remuneration committee for at least 12 months.

Timing

The FRC aims to publish the final version of the Code by early summer 2018, to apply to accounting periods beginning on or after 1 January 2019. As the FRC has already consulted with stakeholders, it seems unlikely that the final version of the Code will differ materially from the consultation version.

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